Equity

Equity on the balance sheet is what the stockholders would have left over after the company paid all of its obligations.  It is one concept of finance. The accounting value of shareholders equity increases when the firm has retained earnings (which result when the income statement shows a profit, and not all profits are distributed in dividends).

Think "stocks" = equity  (while bonds = debt)

The main difference between equity and debt is that equity is what is left over after the company first pays their debts.   So, if the company borrows money from a bank (debt) and also has some money from the owners (equity), then each month the company must first pay back the interest on the loans (and plan on paying back the principal of the loans) before the company can give any money back to the equity holders in a form of "dividends". 

Equity is more expensive to the firm than is debt financing.

While debt is a promise to pay a fixed amount by a certain date....equity carries no such promises.   If you don't make money in the future, you never have to pay back the equity investors!  But, you do have to contractually pay back the debt holders (banks, bondholders, etc).  For this reason, the equity holders are carrying much more risk.  If you only make some money, but not enough to pay both equity and debt holders...then you will pay the debt holders first, and whatever is left over can go to the equity holders.

Because equity holders have more risk, they should also demand a higher return.  When you look at the overall cost of capital for the firm (WACC), it is clear that equity financing is much more expensive, and explains why companies often prefer debt financing in their capital structure decisions. 

If equity is riskier, then why do stockholders invest in a firm?

Because their potential upside returns are much higher.  By investing in the equity of a firm, you are becoming a part-owner of the firm.  If they do well, you will do well. 

While debt holders have a guaranteed minimum amount that they will be paid, that is also the maximum that they will be paid.  They do not get to share in the growth potential if the firm is wildly successful.   Debt holders are paid their interest and principal, but then all other profits go to the owners (equity holders of the firm). 

In financial terms, the equity holders have "contingent claims" on the total value of the firm.  I.e they get the residual value of the firm after the bondholders are paid.   If the value of the firm is less than what is owed to the debt holders, then the equity holders get nothing, and the entire value of the firm goes to the bond holders.

Thinking in terms of Options

The stock of a company can be thought of as a "call option" on the firm.  The value of the call option increases with volatility, and a rise in volatility will increase the value of the stock of the firm.  This means that the value of the stock equity will increase as the firm selects riskier projects.  But, on the other hand, the value of the bond holders will decrease as riskier projects are selected.  This can also be seen in terms of Options.   The value of a risky bond can be seen as the difference between the value of the firm and the value of the call option on the firm.  So, as the value of the call option increases (value of the stock increases), this means that the value of the bonds decreases.  The bondholders are therefore hurt when the firm selects riskier projects. 

Links:

stock market

equity (stock)

issuing shares

Board of Directors

stock options

dividends

stock splits

treasury stock